‘Short US Government’ is as much a political statement as a financial one nowadays. But those allocating to the sector need not be expressing a particularly bearish view on risk assets, or even hawkish expectations about the Federal Reserve. For some, the sector is beginning to replace cash allocations.
For example, Bank of America Merrill Lynch’s Research Investment Committee has twice increased its cash weightings so far this year – by 2% in May and by another 2% in July.
‘History shows that cash generally outperforms when the Fed raises rates,’ explained Martin Mauro, fixed income strategist at the bank. ‘Still, money market funds have not been the best place to benefit from the Fed rate hikes. Yields on money funds have yet to rise meaningfully, despite the 100 basis points in Fed rate hikes since December 2015. We think that money-fund yields will rise more substantially by the end of the year.
‘In the meantime, investors can consider short-term instruments where yields have risen, even though these securities involve some sacrifice of the immediate access to funds and the safety that money funds offer,’ Mauro said.
For instance, the average yield in the ICE US Treasury Short Bond index has more than doubled from 0.48% in October last year to 1.12% today. However, funds in this Citywire sector are not restricted to short-term treasuries; they can also own short-term agency debt to enhance their yields further.
Long-term stars in short-term debt
The manager in this category who has delivered the best risk-adjusted returns over the past three years is Citywire + rated Peter Strzalkowski of the Oppenheimer Limited-Term Government fund. Strzalkowski’s portfolio, which offers a yield of 2.11%, has just a 4.7% weighting to treasuries, with the majority of the rest in agency mortgage-backed securities.
The only other manager in this space with a positive personal information ratio for the period is + rated Dave Fishman of Goldman Sachs, who runs the firm’s Short Duration Government product and the Trust for Credit Unions Short Duration. Fishman forecasts one further rate hike this year, ‘providing financial conditions do not tighten materially and core inflation improves.’ His Goldman portfolio outperformed in the most recent quarter, aided by security selection in the pass-through, collateralized mortgage obligation and adjustable-rate mortgage areas.
A-rated Michael Garrett, a subadvisor on the SEI Short-Duration Government fund, has less exposure to treasuries than Fishman – 20.7% compared with 43.1% – but has also heavily backed collateralized mortgage obligations and agency mortgage-backed security pass-through debt.
Gregg Hrivnak and Richard Figuly, both + rated on the JPMorgan Short Duration Bond fund, have matched Strzalkowski’s total return over the past three years but lag him in risk-adjusted terms. They use treasuries and cash ‘to provide liquidity in periods of market stress,’ and also observe that they ‘can be attractive when spreads are tight,’ but broadly prefer mortgage securities with ‘stable cash-flow profiles’ too.
Completing the top five managers over the past three years is the + rated pair of John Robert Queen III and Ritchie Tuazon on the American Funds Short-Term Bond Fund of America. They profited from taking on more credit risk in the most recent quarter, particularly through asset-backed securities on auto loans.